How does Bitcoin work?

Bitcoin is the fastest way to transfer money internationally, whereas Wire Transfers takes several days. When you pay a cheque from another bank into your bank, the bank will often hold that money for several days. Bitcoin transactions are generally far faster.

With Bitcoin you can send money anywhere, and it will arrive 10 minutes later, after the bitcoin network processes the payment. It takes 10 minutes for the transaction to be checked by the network and proceeded.

Simpler

Bitcoin transactions do not require you to give up any private information. Instead, they use two keys: a public key, and a private one. To send bitcoins, you need two things: a bitcoin address, and a private key.

Cheaper

Transactions with Bitcoin are almost free if the sum transacted is greater than 0.01 BTC. A token sum is imposed to provide some incentive to the miners to include the transaction in the blockchain.

“To send bitcoins, you need two things: a bitcoin address, and a private key”

Bitcoin address

A Bitcoin address is a unique identifier which allows you to receive Bitcoins. Be sure to have copied the destination address exactly before sending Bitcoins to it, as Bitcoin are not reversible.

Every Bitcoin address has a matching private key, which is saved in the wallet file of the person who owns the balance.

Private key

A private key is a secret code which allows the user to prove his ownership of his Bitcoins. Every Bitcoin address has a matching private key, which is saved in the wallet file of the person who owns the balance.

Price

The current market price for a Bitcoin is always changing due to the supply and demand for it. Bitcoins are traded on Bitcoin Exchanges such as MtGox.com. and Bitstamp.

Bitcoin Client

The Bitcoin-QT Client (Downloadable at bitcoin.org) is the original software written by Satoshi Nakamoto, the Bitcoin’s Creator.

Miners

Miners are individuals who run computer systems to repeatedly calculate hashes with the intention to create a successful block and earn coins from transaction fees and new coins created with the block itself. The term references an analogy of gold miners who dig gold out of the ground and thus ‘discover’ new gold that can be used to create new coins, with a similar kind of discovery occurring with a successful hash to create new Bitcoins.

2.2 Bitcoin Protocol

Bitcoin transactions are sent from and to electronic bitcoin wallets and are digitally signed for security. Everyone on the network can know about a transaction, as the history of a transaction can be traced back to the point where the bitcoins were mined (created).

Every transaction that took place is stored in a vast general ledger called the block chain. If you want to know the balance of any bitcoin address, you have to rebuild it using the block chain.

Because your transaction must be verified by miners, you are sometimes forced to wait until they have finished mining. The bitcoin protocol is set so that each block takes roughly 10 minutes to mine you can download the digital goods or take advantage of the service that you paid for.

The mining process currently creates 25 Bitcoins every 10 minutes and the total number of issued Bitcoins has been capped to 21 million Bitcoins. It should be reached in 2040. After this date, the total number of Bitcoins will remain unchanged. It is a trememdous difference with printed currencies such as dollars and euros, instead of Central Banks which constantly issue new money, creating a permanent inflationist monetary system.

2.3 Bitcoin Mining

In traditional fiat money systems, governments simply print more money when they need to. On the contrary, bitcoin is not printed at all but « mined ». Computers around the world “mine” for coins by competing with each other. Everybody can buy bitcoins on the open market, but can also mine. Mining bitcoin requires strong computing power.

The bitcoin network collects all of the transactions made during a set period into a list, called a block. The miners verify and confirm those transactions, and write them into a general ledger : the blockchain.

The Blockchain

The Blockchain is a long list of blocks. Miners all compete with each other to mine blocks. When a block of transactions is created, miners start their work. They apply a mathematical formula turning the block into a hash, which is a far shorter and seemingly random sequences of letters and numbers.

The hash rate is the number of calculations that your hardware can perform every second as it tries to crack the mathematical problem. Every time someone successfully creates a hash, they get a reward of 25 bitcoins, the block chain is updated. Hash rates are measured in megahashes, gigahashes, and terahashes per second (MH/sec, GH/sec, and TH/sec. The higher your hash rate, the more likely you are to solve a transaction block and the more you earn.

Download the software

Depending on which equipment you choose, you will need to run software to make use of it. Typically when using GPUs and FPGAs, you will need a host computer running two things: the standard bitcoin client, and the mining software.

Standard bitcoin client

This software connects your computer to the network and enables it to interact with the bitcoin clients, forwarding transactions and keeping track of the block chain. It will take some time for it to download the entire bitcoin block chain so that it can begin. The bitcoin client effectively relays information between your miner and the bitcoin network.

Bitcoin mining software

The bitcoin mining software is what instructs the hardware to do the hard work, passing through transaction blocks for it to solve. There are a variety of these available, depending on your operating system. They are available for Windows, Mac OS X, and others.

Bitcoin Mining Hardware

There are three main hardware categories for bitcoin miners: GPUs, FPGAs, and ASICs.

CPU/GPU Bitcoin Mining

The least powerful category of bitcoin mining hardware is your computer itself. Theoretically, you could use your computer’s CPU to mine for bitcoins, but in practice, this is so slow by today’s standards that there isn’t any point. You can enhance your bitcoin hash rate by adding graphics hardware to your desktop computer. Graphics cards feature graphical processing units (GPUs). You would rather mine Litecoin, which is designed to be more fair for CPU mining.

FPGA Bitcoin Mining

A Field Programmable Gate Array is an integrated circuit designed to be configured after being built. They offer performance improvements over CPUs and GPUs. Single-chip FPGAs have been seen operating at around 750 Megahashes/sec, although that’s at the high end. It is of course possible to put more than one chip in a box.

ASIC Bitcoin Miners

Application Specific Integrated Circuits (ASICs) are specifically designed to do mine bitcoins at mind-crushing speeds, with relatively low power consumption. with speeds anywhere from 5-500 Gigahashes/sec Vendors are already promising ASIC devices with far more power, stretching up into the 2 Terahashes/sec range.

Mining profitability

Regarding the Energy consumption, you have to divide the hash count by the number of watts to work out how many hashes you are getting for every watt of electricity that you use.

One of the other key parameters is network difficulty. This metric determines how hard it is to solve transaction blocks, and it varies according to the network hash rate.

Mining Pools

Most mining these days is the domain of large mining groups called « mining pools ». Mining pools are defined as groups of miners working together to solve a block and sharing the rewards of that block.